Preservation of loss carry-forwards despite acquisition of more than 50% of the shares

The preservation of loss carry-forwards has been the subject matter of numerous legislative projects. In order to prevent well-earning (and thus taxable) companies from acquiring empty-shell limited liability companies with high loss carry-forwards for the purposes of carrying out a merger and using the loss carry-forwards to reduce their own tax burden, the German legislature enacted new rules as early as the Eighties. Under those rules, loss carry-forwards were only allowed to be used if “predominantly new business assets” were injected (former § 8 para. (4) German Corporate Income Tax Act). This led to an unclear legal situation and, as a consequence, to many judicial proceedings. In 2007, the German legislature decided to enact significantly stricter rules by introducing § 8c Corporate Income Tax Act, under which the acquisition of more than 25% of the shares led to a proportionate forfeiture of loss carry-forwards and the acquisition of more than 50% of the shares to the complete forfeiture of all loss carry-forwards. The details are even more complicated.

In any case, the legislature introduced early on a so-called restructuring clause according to which there was no forfeiture of loss carry-forwards if the shares were acquired during a crisis and the acquisition was made for restructuring purposes. It was believed that without such a clause, a potential investor might wait until the company was insolvent in order to then purchase the business and benefit at least from write-downs or write-offs.

The current provisions of § 8c para. (1a) Corporate Income Tax Act have applied since 2019 and read as follows: “Paragraph (1) does not apply to an acquisition of shares carried out for the purposes of restructuring the legal entity’s business. Restructuring means a measure designed to prevent or put an end to insolvency or over-indebtedness whilst preserving the fundamental business structures.”

Modification:

A draft circular from the German Federal Ministry of Finance to the highest fiscal authorities of the German states now clarifies some (controversial) details of the provisions:

Requirements for restructuring

The application of the restructuring clause presupposes that, at the time of acquisition of the shares, the legal entity is in need of restructuring and capable of being restructured.

The legal entity is considered to be in need of restructuring if it is at risk of becoming illiquid – that is, unable to meet its payment obligations as and when they fall due –  and/or overindebted or has already become illiquid and/or overindebted (§ 17 to § 19 German Insolvency Code), i.e. a crisis.

The legal entity is capable of being restructured if resolving the crisis by means of the intended measures is feasible from an objective perspective.

Further requirements

The “preservation of the fundamental business structures” criterion is met if:

1. a works agreement containing job-related provisions has been entered into or
2. the wage bill is maintained in accordance with a certain formula or
3. significant business assets are injected.

1. Works agreement

An assumption to the effect that fundamental business structures are being preserved inevitably requires the conclusion of a works agreement in a business unit employing at least half of the employees. The works agreement must contain provisions regarding preserving and securing the jobs. A minimum number of jobs that need to be preserved has not been defined, however. The works agreement must be actually implemented.

2. Wage bill rule

According to the law, “the relevant annual wage bills of the legal entity during the five-year period that follows the acquisition of the shares [must] together total 400 per cent or more of the initial wage bill”. This often led to confusion because it was unclear what reference value should be used. The Federal Ministry of Finance circular clarifies in this respect that the last five years prior to the acquisition of the shares are decisive for the determination of the initial wage bill. The circular further clarifies that this rule does not apply to legal entities with not more than ten employees.

3. Significant business assets

The Federal Ministry of Finance circular clarifies that the injection of business assets amounting to 25% within the 12-month period following the acquisition of the shares may be made either into the nominal capital or into the capital reserves. The latter is much easier to implement, from a corporate law perspective. Premiums are also to be classified as an injection. A waiver of financial claims may only be taken into account to the extent that the relevant claims were recoverable at the time the waiver was made.

If the aforesaid requirements are reversed after the acquisition of the shares, the preserved loss carry-forwards will be subsequently forfeited.

The circular of the Federal Ministry of Finance, if published in this form, will clarify some cases of doubt, thus making it easier to plan investments during a corporate crisis. Further improvements are conceivable – but that’s another story for another time.